Page 662 - Economics

CONFIRMING PAGES

CHAPTER 29
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Public Choice Theory and the Economics of Taxation
It is difficult to measure precisely how the benefits of Ability-to-Pay Principle The ability-to-pay
public goods are apportioned among individuals and insti- principle of taxation asserts that the tax burden should be
tutions. We cannot accurately determine how much citizen apportioned according to taxpayers’ income and wealth. In
Mildred Moore benefits from military installations, a net- the United States this means that individuals and businesses
work of highways, a public school system, the national with larger incomes should pay more taxes in both absolute
weather bureau, and local police and fire protection. and relative terms than those with smaller incomes.
The situation is different when it comes to paying for What is the rationale of ability-to-pay taxation? Pro-
those benefits. Studies reveal with reasonable clarity how ponents argue that each additional dollar of income
the overall tax burden is apportioned. (By “tax burden” we received by a household yields a smaller amount of satis-
mean the total cost of taxes imposed on society.) This ap- faction or marginal utility when it is spent. Because con-
portionment question affects each of us. The overall level sumers act rationally, the first dollars of income received
of taxes is important, but the average citizen is much more in any time period will be spent on high-urgency goods
concerned with his or her part of the overall tax burden. that yield the greatest marginal utility. Successive dollars
of income will go for less urgently needed goods and fi-
Benefits Received versus nally for trivial goods and services. This means that a dol-
lar taken through taxes from a poor person who has few
Ability to Pay dollars represents a greater utility sacrifice than a dollar
There are two basic philosophies on how the economy’s taken through taxes from a rich person who has many dol-
tax burden should be apportioned.
lars. To balance the sacrifices that taxes impose on income
receivers, taxes should be apportioned according to the
Benefits-Received Principle The benefits- amount of income a taxpayer receives.
received principle of taxation asserts that households and This argument is appealing, but application problems
businesses should purchase the goods and services of gov- arise here too. Although we might agree that the household
ernment in the same way they buy other commodities. earning $100,000 per year has a greater ability to pay taxes
Those who benefit most from government-supplied goods than a household receiving $10,000, we don’t know exactly
or services should pay the taxes necessary to finance them. how much more ability to pay the first family has. Should
A few public goods are now financed on this basis. For ex- the wealthier family pay the same percentage of its larger
ample, money collected as gasoline taxes is typically used income, and hence a larger absolute amount, as taxes? Or
to finance highway construction and repairs. Thus people should it be made to pay a larger fraction of its income as
who benefit from good roads pay the cost of those roads. taxes? And how much larger should that fraction be?
Difficulties immediately arise, however, when we consider There is no scientific way of making utility compari-
widespread application of the benefits-received principle: sons among individuals and thus of measuring someone’s
• How will the government determine the benefits that relative ability to pay taxes. That is the main problem. In
individual households and businesses receive from practice, the solution hinges on guesswork, the tax views
national defense, education, the court system, and of the political party in power, expediency, and how ur-
police and fire protection? Recall that public goods gently the government needs revenue.
are characterized by nonrivalry and nonexcludability.
So benefits from public goods are especially wide-
spread and diffuse. Even in the seemingly straightfor- Progressive, Proportional,
ward case of highway financing it is difficult to and Regressive Taxes
measure benefits. Good roads benefit owners of cars Any discussion of taxation leads ultimately to the question
in different degrees. But others also benefit. For ex- of tax rates. Recall from Chapter 4 that an average tax rate
ample, businesses benefit because good roads bring is the total tax paid divided by some base against which the
them customers. tax is compared.
• The benefits-received principle cannot logically be
applied to income redistribution programs. It would Definitions Taxes are classified as progressive, pro-
be absurd and self-defeating to ask poor families to portional, or regressive, depending on the relationship
pay the taxes needed to finance their welfare pay- between average tax rates and taxpayer incomes. We focus
ments. It would be ridiculous to think of taxing only on incomes because all taxes, whether on income or on a
unemployed workers to finance the unemployment product or a building or a parcel of land, are ultimately
compensation payments they receive. paid out of someone’s income.

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